Some Investors May Be Worried About Hunan Haili Chemical IndustryLtd's (SHSE:600731) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Hunan Haili Chemical IndustryLtd (SHSE:600731) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Hunan Haili Chemical IndustryLtd, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.031 = CN¥114m ÷ (CN¥4.2b - CN¥515m) (Based on the trailing twelve months to March 2024).

Therefore, Hunan Haili Chemical IndustryLtd has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Hunan Haili Chemical IndustryLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Hunan Haili Chemical IndustryLtd's past further, check out this free graph covering Hunan Haili Chemical IndustryLtd's past earnings, revenue and cash flow.

So How Is Hunan Haili Chemical IndustryLtd's ROCE Trending?

When we looked at the ROCE trend at Hunan Haili Chemical IndustryLtd, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 3.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hunan Haili Chemical IndustryLtd has done well to pay down its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

In summary, we're somewhat concerned by Hunan Haili Chemical IndustryLtd's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 10% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 2 warning signs for Hunan Haili Chemical IndustryLtd that we think you should be aware of.

While Hunan Haili Chemical IndustryLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.